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Barely more than a year since the Swiss National Bank’s removed its cap on the Swiss Franc, surprising traders and plunging currency markets into chaos, the Bank of Japan unexpectedly announced the adoption of a negative interest rate last night. This time around, so far, no forex brokers are reporting any exceptional losses, despite the Yen plummeting 2% overnight.
In this short article we take a look at what the move means for forex brokers, and ask why it hasn’t had the devastating impact of last year’s Swiss Franc liquidity crisis.
The Right Kind of Shock
Although the Japanese Yen announcement was unexpected, it is perfectly in line with what is generally anticipated from Japanese monetary policy. The Bank of Japan aims to for a 2% rate of inflation and low interest rates which international borrowing, and last night’s move is an extension of this strategy, as confirmed by the Governor of country’s central bank, Haruhiko Kuroda:
What’s important is to show people that the Bank of Japan is strongly committed to achieving 2 percent inflation and that it will do whatever it takes to achieve it. But there’s a risk recent further falls in oil prices, uncertainty over emerging economies, including China, and global market instability could hurt business confidence and delay the eradication of people’s deflationary mindset. The BOJ decided to adopt negative interest rates … to forestall such risks from materializing
Large Net Shorts
The Japanese Yen is one of the currencies of choice for the carry trade, and this means that many large traders and institutions are perennially short the Yen. By borrowing the currency at extremely low, and now negative, rates of inflation, exchanging these for a currency such as the US Dollar, and then purchasing higher yielding securities such as Treasury Bonds, those who participate in the carry trade aim to profit from the interest rate differential between the two countries.
Despite a recent upswing in prices for the Yen, doubly mystifying with the US Federal Reserve having recently announced plans for a further four rate hikes in successive quarters, many large traders would have been positioned short of the Yen and would have profited from last night’s announcement.
Robust Business Models
With the volatility of the markets over the past month, primarily caused by concerns over the slowdown in China’s economic growth and plunging oil prices, both traders and forex brokerage firms were already braced for this kind of market shock. Just like investors, brokers have adopted a ‘risk-off’ stance, increasing margin requirements and tightening position limits.
There’s also an element of “survival of the fittest” at work here: as identified in this article from Finance Magnates, those firms that suffered little negative impact from the CHF crisis are likely to be the ones that have the most robust systems in place to manage volatile market conditions and sudden shock price movements following key shifts in economic policy.
In the wake of the Swiss Franc crisis, many of the brokers that were not forced into liquidation but suffered significant net losses across client accounts have sought to put in place additional measures to manage systemic currency risks and insure against precisely this type of event. Monex Group, which owns TradeStation and IBFX, has adjusted margins for forex traders several times over the past year in an attempt to preempt a repeat of it’s losses last January.
Though no new regulations have been passed to, the forex brokerage industry has been fairly self-regulating in this respect following the collapse of Alpari UK last January. Concerns from both the UK’s FCA and Ireland’s Central Bank over risk management expertise in financial derivatives are rumored to have been a factor in regulator opposition to the acquisition of forex and CFD brokers Plus500 and AvaTrade by FTSE250 listed Playtech last year. Both firms reported that the Swiss Franc liquidity crisis had “no material impact” on their financial position however.
Long Term for the Japanese Yen
As Saxo Bank / TradingFloor.com’s lead analyst John Hardy has identified in his comments to LeapRate, there’s a lot of confusion surrounding the Bank of Japan’s intentions with last night’s policy change, and it is unclear how negative interest rates will play out for the currency and the country’s economic stability over the long term:
What is not clear is how the BoJ expects this to help the Japanese economy. Negative rates are hard on banks, and bank credit is the lifeblood of modern economies, together with fiscal outlays. Furthermore this move could prove disruptive for the BoJ’s own quantitative and qualitative easing policy. . . Somehow this BoJ move looks like desperation and ineffective, last-ditch defense, and I’m not so sure that we get a sustained move on the back of it. . . The tricky part will be to define “sustained” – a few days to a couple of weeks is my expected time frame.
So it may be some time before forex brokers and their clients can truly heave a sigh of relief and know that they’ve escaped this particular storm unscathed.